An underlying asset is the asset on which the price of a derivative depends. Most traded derivatives (i.e. those traded on exchanges) are settled for cash, not by actual delivery of the underlying.
Some derivatives, such as CFDs, do not actually involve even a possible trade in an underlying security. They are simply a contract to exchange cash depending on the underlying. This means that they can use an underlying that cannot itself be delivered (such as an index value, weather conditions etc.)